Mortgage Prepayment Penalties

Mortgage Prepayment Penalties

Did you know some mortgages have something known as a prepayment penalty? This loan feature is not common, but it is part of some home loans. Mortgages with a prepayment penalty obligate the borrower to pay a penalty if the loan is paid off early, which is usually defined as within five years of the origination date.

Loan Prepayment Penalty Clause

Many loans never have prepayment penalties including FHA loans, VA loans and USDA loans. These government-backed mortgages can be paid off early with no penalty. Many homeowners do discover that their home loan or second mortgage has a prepayment penalty clause. It is important to understand this feature, as it may mean you cannot benefit from lower interest rates by refinancing.

There is an advantage to accepting a loan with a prepayment penalty: you will likely get a lower interest rate.

Prepayment Penalties

Prepayment Mortgage Penalties

Mortgage lenders will calculate an expected return on their investment before making a loan, which includes a calculation of how long the borrower must hold the loan before it prepays.

Most borrowers only pay off their loan early when they refinance into a new loan with a better rate or do a cash out refinance. Prepayment penalties on loans are usually 2-4% of the loan. Some penalties are a flat fee and some work on a sliding scale. This means the penalty amount reduces as the loan is held. Sometimes the penalty is only required under certain conditions such as selling the home, but not refinancing or otherwise paying it off early.


Paying Prepayment Penalty

While you likely do not want to get stuck with a penalty, bear in mind that loans with a penalty are not always bad. As long as you understand how the penalty works, the penalty fits into your homeownership plans, and you can get a better rate or lower loan costs in exchange for accepting the penalty, then the prepayment penalty may work for you.

However, it may make more financial sense to pay the prepayment penalty in order to refinance into a new mortgage with a lower rate. You will need to consider how much you will save and determine if it is worth the cost. A prepayment penalty may also be acceptable if you do it to get out of a loan with a balloon payment that is almost due.

Fortunately, avoiding prepayment penalties is very easy because few lenders offer them.

Home Loan Prepayment Penalties

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